Discussion paper

DP11947 Deposit Insurance and Reinsurance: A General Equilibrium Perspective

We study the consequences and optimal design of bank deposit insurance
and reinsurance in a general equilibrium setting. The model involves two
production sectors. One sector is financed by issuing bonds to risk–averse
households. Firms in the other sector are monitored and financed by banks.
Households fund banks through deposits and equity. Deposits are explicitly
insured by a deposit insurance fund. Any remaining shortfall is implicitly
guaranteed by the government. The deposit insurance fund charges banks a
premium per unit of deposits whereas the government finances any necessary
bail-outs by lump-sum taxation of households. When the deposit insurance
premium is actuarially fair or higher than actuarially fair, two types of equilibria
emerge: One type of equilibria supports the Pareto optimal allocation,
and the other type does not. In the latter case, bank lending is too large
relative to equity and the probability that the banking system collapses is
positive. Next, we show that a judicious combination of deposit insurance
and reinsurance eliminates all non–optimal equilibrium allocations. Our paper
provides a benchmark result for policy proposals that advocate deposit
insurance cum reinsurance.


Gersbach, H, V Britz and H Haller (2017), ‘DP11947 Deposit Insurance and Reinsurance: A General Equilibrium Perspective‘, CEPR Discussion Paper No. 11947. CEPR Press, Paris & London. https://cepr.org/publications/dp11947